Highlights
Wednesday evening after market close in the U.S., Fed Vice Chair Janet Yellen added to the Fed debate on the likelihood of further ease and she clearing is leaning toward additional Fed moves. She sees substantial downside risks to the recovery. Yellen stated that there is room for further accommodation of some type (not indicating a likely choice) and that it may be appropriate to insure against adverse shocks to the economy. Yellen pointed out that consumer spending is being constrained as households continue to work off debt-which she expects to continue for some time. She sees the pending fiscal cliff as a serious concern and, as other economists, continues to worry that the outlook for economic growth continues to be weighed upon by strains on global markets from European sovereign debt problems.

Overall, the Fed vice chair anticipates moderate growth, inflation at or below the Fed's goal of 2 percent, and unemployment easing very slowly.

"To anticipate the main points, the economy appears to be expanding at a moderate pace. The unemployment rate is almost 1 percentage point lower than it was a year ago, but we are still far from full employment. Looking ahead, I anticipate that significant headwinds will continue to restrain the pace of the recovery so that the remaining employment gap is likely to close only slowly. At the same time, inflation (abstracting from the transitory effects of movements in oil prices) has been running near 2 percent over the past two years, and I expect it to remain at or below the Federal Open Market Committee's (the FOMC's) 2 percent objective for the foreseeable future."

"The deceleration of payroll employment from the first to the second quarter was probably exacerbated by some combination of seasonal adjustment difficulties and an unusually mild winter that likely boosted employment growth earlier in the year. Payback for that earlier strength probably accounts for some of the weakness we've seen recently. Smoothing through these fluctuations, the average pace of job creation for the year to date, as well as recent unemployment benefit claims data and other indicators, appear to be consistent with an economy expanding at only a moderate rate, close to its potential. Such modest growth would imply little additional progress in the near term in improving labor market conditions, which remain very weak."

"All told, only about half of the collapse in private payroll employment in 2008 and 2009 has been reversed. A critical question for monetary policy is the extent to which these numbers reflect a shortfall from full employment versus a rise in structural unemployment. While the magnitude of structural unemployment is uncertain, I read the evidence as suggesting that the bulk of the rise during the recession was cyclical, not structural in nature."

Yellen sees inflation easing, implicitly indicating she believes the Fed has room for further accommodation.

"In recent weeks, however, oil and gasoline prices have moderated and are now showing through to the headline inflation figures. Looking ahead, most FOMC participants at the time of our April meeting expected inflation to be at, or a bit below, our long-run objective of 2 percent through 2014; private forecasters on average also expect inflation to be close to 2 percent. As with unemployment, uncertainty around the inflation projection is substantial."

The vice chair builds arguments that recent Fed accommodation has been successful, implying that more of the same will have some positive effect on economic growth.

"Research by Federal Reserve staff and others suggests that our balance sheet operations have had substantial effects on longer-term Treasury yields, principally by reducing term premiums on longer-dated Treasury securities."

Yellen argues that continued substantial accommodation is appropriate based on staff econometric analysis of policy options, noting that Fed policy rates should be lower than even implied by application of the Taylor Rule-relating to real fed funds, the inflation gap, and unemployment gap. She adds that recent and unique headwinds argue for continued loose policy. Yellen ends by stating that the next policy change could go either way but her language in prepared remarks certainly is leaning more toward additional ease than to sooner tightening.

"If the recovery were to proceed faster than expected or if inflation pressures were to pick up materially, the FOMC could adjust policy by bringing forward the expected date of tightening. In contrast, if the Committee judges that the recovery is proceeding at an insufficient pace, we could undertake portfolio actions such as additional asset purchases or a further maturity extension program. It is for this reason that the FOMC emphasized, in its statement following the April meeting, that it would "regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.""